Reserve Bank of India Leaves Policy Rates on Hold

In its December meeting, the Reserve Bank of India kept its rates on hold following two successive 25 basis points hikes. The Bank decided to wait for further data despite high levels of inflation.

Excerpts from The Reserve Bank of India Mid-Quarter Review of Monetary Policy:

On the basis of an assessment of the current and evolving macroeconomic situation, it has been decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 7.75 per cent and to keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liability (NDTL). Consequently, the reverse repo rate under the LAF will remain unchanged at 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 8.75 per cent.

Recent readings suggest that headline inflation, both retail and wholesale, have increased, mainly on account of food prices. While CPI and wholesale price index (WPI) inflation excluding food and fuel have been stable, despite a steady and necessary increase in administered prices towards market levels, the high level of CPI inflation excluding food and fuel leaves no room for complacency. The negative output gap, including the recent observed slowdown in services growth, as well as the lagged effects of effective monetary tightening since July, should help contain inflation.

The policy decision is a close one. Current inflation is too high. However, given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, there is merit in waiting for more data to reduce uncertainty.

There are obvious risks to waiting for more data, including the possibility that tapering of quantitative easing by the US Fed may disrupt external markets and that the Reserve Bank may be perceived to be soft on inflation. The Reserve Bank will be vigilant. Even though the Reserve Bank maintains status quo today, it can help guide market expectations through a clearer description of its policy reaction function: if the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold. The Reserve Bank’s policy action on those dates will be appropriately calibrated.

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